Does Joining the S&P 500 Index Hurt Firms?

It seems to these days:

We investigate the impact on firms of joining the S&P 500 index from 1997 to 2017. We find that the positive announcement effect on the stock price of index inclusion has disappeared and the long-run impact of index inclusion has become negative. Inclusion worsens stock price informativeness and some aspects of governance. Compensation, investment, and financial policies change with index inclusion. For instance, payout policies of firms joining the index become more similar to the policies of their index peers. ROA falls following inclusion. There is no evidence of an impact of inclusion on competition.

That is from Benjamin Bennett, René M. Stulz, and Zexi Wang.  Here is the NBER paper, here is an ungated copy.

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Evidence for the Efficient Market hypothesis? Or evidence against it? Investors are savvy enough to not over-value firms in the S&P 500. But does the long run negative impact imply that investors are being too pessimistic or that it changes the makeup of investors? And thus evidence against the EMH?

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Four years ago this month, General Motors , once the largest issue in the S&P 500, was removed from the index when it filed for Chapter 11 bankruptcy as part of a government-orchestrated bailout.

Earlier this week, S&P announced GM’s return to the index -- it will replace HJ Heinz as the ketchup maker is being taken private by Berkshire Hathaway and 3G Capital -- and when the automaker rejoins the 500-stock roster after the closing bell Thursday it will be marking a milestone on an unusual journey.

In general, S&P 500 companies that go bankrupt are rare. Usually a failing business will be removed from the index long before a Chapter 11 filing. But sometimes a company's downturn can be drastic enough that the decision-makers are a bit behind the curve.

Recent examples include Lehman Brother's epic bankruptcy in September 2008, after the U.S. government and other investment banks could not reach a deal to save the company. The firm not only filed for Chapter 11, but was plucked from the S&P 500 simultaneously. Similarly, when the FDIC seized Washington Mutual just weeks after Lehman's collapse, the bank was an S&P 500 member until its demise. - from Forbes

"In general, S&P 500 companies that go bankrupt are rare. "

https://markets.businessinsider.com/news/stocks/tesla-stock-added-sp500-index-what-has-happen-next-step-2020-7-1029428368

Well here's one that hasn't made it yet (but it will) but I will prognosticate that it will do precisely that. The 'next generation' are going to be far more fragile. Feel free to screencap this. TSLA is all hat, no cattle.

You missed the sentence following your quote - "Usually a failing business will be removed from the index long before a Chapter 11 filing."

Odds are good - not perfect - that S&P will be able to do that one trick that keeps the S&P 500 rocking

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Yes it’s not completely passively managed.

Did you have a point prior?

It's a standard prior passive aggressive attack.

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Actually, 3G Capital has been created by Brazilians.

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This happened back in 2013

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Well, joining the S&P certainly seem to reduce competition in the market(s) where the company operates: https://www.law.northwestern.edu/research-faculty/clbe/events/antitrust/documents/boller_scottmorton_common_ownership.pdf

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They should let hedge funds pick the S&P 500 every year like an NFL draft. I'd watch that.

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Selection effect? The index is made up of big firms in mature markets, growth opportunities become more limited, ROA falls.

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Sounds like mean reversion could be a factor.

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Index funds? In a few weeks, you won’t have to pay $1500 to own a piece of Tesla. You can pay a fifth of that for SPY.

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Is this an example of punishing an outlier, in this case an outlier in the S&P 500? Independent outliers are often rewarded but not outliers that are part of a group. Conformity among group members is promoted in order to reward the group. Tesla investors are investing in Musk, and look to him for signals. Index investors are investing in the group, and look upon outliers and volatile personalities within the group as disruptive. Inclusion of Tesla in the index might moderate Musk's behavior, reducing the volatility of Tesla stock: fewer large increases in price and fewer large declines. As for Tesla itself, I don't see how its product can be considered anything other than satisfying a market niche. There has to be a low ceiling for a car that (a) is expensive, (b) has a limited range, (c) has untested quality, durability, and safety, and (d) sounds like a sewing machine. As for Musk, no index is going to control him because he isn't motivated by the things that motivate others. Oddly, Tesla shares have surged on the expectation that Tesla will be added to the index. Is that because investors are hoping it will moderate Musk's behavior? That makes little sense. But today's stock prices don't make much sense either, except for the Fed's promise that it will do "whatever it takes" to maintain asset (i.e., stock) prices.

That seems like deliberately too-chilly assessment of a vehicle that has literally changed the future of cars. Engineering experts say Tesla is years ahead of other automakers in battery, software, motor and control technology. Range is getting up near gas cars, power blows them away, driving characteristics are superb. And they had the foresight - alone in the world - to build out a charging system simultaneously with their product.
And yes, the investors do "invest in Musk". Sometimes that's the way to go, as in investing in Gates, or Buffett or Jobs or Nadella.

At the same time Tesla is so very sad and disappointing.

People born in the 1960's learned about cars as children, as the cars were at the time, and thought, "is this a joke?". Explosions move pistons in one dimension. Actual explosions because we were crude by necessity. It's not even rotary, except for the few Wankels being sold. Crankshafts looked retro even when they were state of the art. It was steampunk before the word was coined. We even had an electric car in our school electronics shop in the 1970s. By the time we were adults nothing had changed.

I worked with a guy who told me he thought "I don't need to know this stuff because by the time I'm an adult this won't exist anymore".

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I tried Googling "Zexi Wang" and OMG.

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Regression to the mean.

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Arnold Kling has an excellent post the other day on how just 4 forms account for more than a fifth of the S&P 500. https://www.arnoldkling.com/blog/the-sp-4/ He asks some relevant questions:

“Consider portfolio theory. The idea is that you diversify by holding the market portfolio. But if the market portfolio is itself not diverse, what does that imply? My first thought is it you should require a higher expected return.
Consider industrial organization. Economists usually measure market power by looking at a firm’s share of market sales. But should share of market capitalization be an indicator? Does Amazon’s share of market capitalization in retail predict its future share of market sales in retail?”

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The effect on each individual company shouldn't matter to an investor. Investors should only be concerned with the overall index's pricing, resilience and performance.

Learn a lesson from horses and oxen. If you want the power of a team of animals, you don't want one running out in front while others drag behind. There's a lot of harnessing and yoking technology for balancing speed and power output. You might not get optimal horse or optimal ox, but you get something better.

Economists have little grasp of complex systems. They imagine that each component needs to be optimal, but you couldn't even run a bodega like that, let alone a modern corporation or a society.

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